Crypto basics for beginners: what crypto is and how crypto works?

Crypto basics for beginners: cryptocurrency has gained significant attention over the past few years, becoming a popular topic in finance and technology.

What is cryptocurrency? Cryptocurrency is a system of value. When investors purchase a cryptocurrency, they are essentially betting that the asset's value will increase over time, similar to how stock market investors buy shares in a company they believe will grow.

Unlike traditional stock valuations, which rely on discounted estimates of a company's future cash flows, cryptocurrencies lack an underlying entity to evaluate. Their value is primarily driven by investor sentiment and demand.

Cryptocurrency valuations hinge on two main factors: the likelihood that other investors will buy the asset and the utility provided by the cryptocurrency's underlying blockchain technology.

How Does Cryptocurrency Work?

Cryptocurrency operates on blockchain technology, but what exactly is a blockchain? The term has become widely used, often leading to confusion about its meaning. A blockchain is essentially a digital ledger of transactions that is distributed across a network of computer systems. No single entity controls this ledger; instead, it is maintained by a decentralized network that authenticates transactions.

Advantages and Disadvantages of Blockchain

Proponents argue that blockchain enhances transparency, trust, and data security across networks. However, critics point out that blockchain can be cumbersome, inefficient, and energy-intensive.

Rational investors typically buy digital assets based on their faith in the strength and utility of the underlying blockchain. Since all cryptocurrencies rely on blockchain technology, investors are, whether they realize it or not, betting on the resilience and appeal of that system.

Transaction Recording and Validation

Transactions are permanently recorded on the blockchain. Groups of transactions are compiled into ‘blocks,’ which validate the authenticity of the transactions and keep the network operational. All transactions are stored on a public ledger, allowing anyone to view activities on major blockchains like Bitcoin (BTC) and Ethereum (ETH).

The Role of Miners
Why do individuals dedicate computing power to validate blockchain transactions? They are rewarded with the cryptocurrency itself. This incentive-based system is known as a proof-of-work (PoW) mechanism. The computers that validate transactions are referred to as miners, and in exchange for their efforts, they earn newly minted crypto assets.

Digital Wallets and Keys
Cryptocurrency holders do not store their assets in traditional bank accounts. Instead, they use digital addresses that come with private and public keys—long strings of numbers and letters. Private keys allow users to unlock and send cryptocurrency, while public keys enable them to receive funds from others.

The Impact of Bitcoin

Bitcoin has fundamentally changed the financial landscape, introducing unprecedented technology and a new approach to investing and money management. Initially emerging as a grassroots movement with an anti-establishment ethos, cryptocurrencies are now being embraced by corporations and financial institutions for their potential to disrupt outdated systems and diversify investment portfolios.

As innovations continue to shape the cryptocurrency sector—such as exciting developments in decentralized finance (DeFi)—the definition and implications of cryptocurrency will keep evolving.

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Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice. Trading cryptocurrency CFDs and spread bets is restricted for all UK retail clients.